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2 TABLE OF CONTENTS 1. EXECUTIVE SUMMARY 4 2. KNOWLEDGE AS A PRODUCTION FACTOR GLOBAL LEADERS AND COMPETITORS LESSONS FOR TURKEY Key Success Factors In The Knowledge Economy Key Challenges For Turkey Capacity of the Business Sector to Support Knowledge Economy INNOVATION POLICY FOR KNOWLEDGE ECONOMY Trends And Issues The Innovation Climate Innovation Policy Direction Policy Options HUMAN RESOURCES FOR THE KNOWLEDGE SOCIETY Trends And Issues Human Resources For The KE: The Education Challenge Policy Issues In The Education And Training Sector Conclusions ICT FOR THE KNOWLEDGE ECONOMY Trends And Issues Policy Recommendations Conclusions BUSINESS ENVIRONMENT AND THE KE Trends And Issues Macroeconomic Volatility and the Knowledge Economy Public Governance and Knowledge Economy Participatory Policy Making For Knowledge Economy Conclusions IMPLEMENTING THE KE AGENDA Implementation Guidelines Building Blocks Institutional Capacity ANNEX I. Policy Recommendations At A Glance ANNEX II. Turkey And Its KE Competitors.. 88 This study was prepared by Gregory T. Jedrzejczak, Task Manager, ECSPF; Jean-Eric Aubert, WBI; David Herbert Fretwell, ECSHD; and Gareth Locksley, CITPO. Gurhan Ozdora, Ferda Sahmali, Ibrahim Akcayoglu, Mohini Bhatia and Tunya Celasin. Severin Koddertizsch, and the KE Project team contributed to the study. Omer Karasapan, Jacques Morisset and Marialisa Motta were the peer reviewers. Information, insights, and comments were provided from many agencies in Turkey, including the State Planning Organization (main counterpart), Ministry of Finance, Undersecretariat of the Treasury, Ministry of National Education, Telecomunication Agency, TUBITAK, TTGV, TOBB, TUSIAD, KOSGEB, YOK, the Turkish Informatics Foundation, Istanbul Technical University, Bilkent University, and others. Thanks are also due to the many individuals from the business community, NGOs, and academia who provided important comments and insights.

6 1 EXECUTIVE SUMMARY 1.1 KNOWLEDGE AS A NEW PRODUCTION FACTOR Products such as computer software, media and entertainment content, new pharmaceuticals, and online commerce and banking services belong to the knowledge economy. Despite great diversity of functions and technologies, their common characteristic is that their production requires a relatively high intellectual input (knowledge) and depends less on the traditional production factors of labor and land. However, there is also an increasing knowledge content in the production and marketing of traditional products such as food, textiles, or tourism. Countries such as the United States, Finland, and Ireland are widely recognized as leaders successfully transforming to a knowledge economy, dramatically increasing their productivity and global competitiveness, creating new jobs, and, over the longer term, enhancing the well-being of their citizens. This first rank of countries is followed by a second tier of countries, including Turkey, that are competing to reap the benefits of their own knowledge economy. Turkey in particular is at a similar stage of development to the EU accession countries, and furthermore is focused broadly on the same markets and products. The difference between traditional production factors and knowledge as a production factor is that the latter is a systemic factor, a result of interlinked socioeconomic elements. These elements, which comprise the four pillars of a knowledge economy, are as follows: the innovation policies, institutions, and incentives necessary for the development and commercialization of domestic and foreign innovations that is, for the creation of a national innovation system; human resource development specifically, the development of a national education system generating a pool of knowledge specialists and a technologyliterate work force; information and communication technologies (ICT); and a business environment conducive to the development of a knowledge economy. 1.2 GLOBAL LEADERS AND COMPETITORS: LESSONS FOR TURKEY The experience of those countries that are most advanced in their transformation to a knowledge economy suggests that such an economy for the most part emerges from 4

7 within the existing business universe. Most successful knowledge economies have been built on the strength of existing brand names, client base, staff and capital resources. In the context of these findings Turkey is in a relatively strong position to built its knowledge economy. Its international brand recognition is good and there exists within EU markets a positive image of many goods made in Turkey. However, the assessment of Turkish readiness for the knowledge economy shows that much remains to be done. Also, due to the last crisis, Turkey has regressed in some important areas. In particular, the situation relatively worsened in the business environment and preparedness of the educational system to respond to the needs and challenges of the knowledge economy. The Turkish business universe historically has been dominated by three types of enterprises: state enterprises, which receive preferential treatment and thus have little incentive to innovate; large family firms that have learnt their way around the regulatory system, but which because of the unsupportive business environment are more conservative in their business practices that their managerial and resource potential would indicate; and small, mostly subsistence businesses, often in the informal sector, that have a short-term survival agenda and neither the resources nor the incentive to change. The challenge for Turkey is to develop a support system for enterprises that will enable them to leverage their entrepreneurial strengths for growth. The country s relatively weak ability to generate new firms and to support creative ones is in part a result of the weak networks linking the different types of firms, including small and medium-size enterprises (SMEs). In successful knowledge economies these networks typically are dense and open, permitting and encouraging a constant flow of goods and services, people, and ideas. 1.3 INNOVATION POLICY FOR THE KNOWLEDGE ECONOMY Some enterprises (and even sectors) of the Turkish economy hold a prominent position in the European markets. The country s competitiveness has been built primarily on its low labor costs, however, an advantage that inevitably will erode with the rise of competitors from Eastern Europe and Asia. Those industries, such as textiles manufacturing, that are highly labor-intensive will find themselves under increasing threat. While the number of companies conducting research and development (R&D) rose between 1996 and 2000, the business sector does not make enough investment in this area. The share of the business sector in total R&D expenditure is around 35 percent, compared to the 65 percent OECD average. More than 60 percent of Turkey s R&D effort is undertaken by universities (compared to the 25 percent OECD average), with practically all R&D infrastructure located in Ankara and Istanbul. While the potential of the universities to innovate is strong, university industry relations furthermore are weak. There is inadequate funding for cooperative projects and research facilities and 5

8 equipment are in some cases limited. Attitudes and incentives also are a problem: university professors are mostly encouraged to focus on theoretical work, and there appears to be little awareness among businesses of the scientific and technical capabilities of the universities. Commercial financing for innovation and R&D is in short supply and venture finance is scarce. Tax incentives also are modest, benefiting only large firms. Much however is expected of the association with the EU Framework Program, which should stimulate the R&D and innovation climate, facilitating the integration of Turkish R&D teams into European networks and providing them with significant support. There is a clear need to promote new enterprises that can compete on the world market, and that are capable of becoming a significant source of jobs and exports. To strengthen the innovation support services for small and medium-size start-up enterprises and new research ventures, the government should investigate the potential of a financial support mechanism that has a public nature but a private sector orientation. It is essential that any such support be deployed in a truly decentralized way, with the local business and administrative communities taking a significant ownership role. Measures specifically addressed to SMEs, such as the competitively allocated partial matching financing of contracts made with universities or laboratories, also could encourage the development of the vital relationship of industry with research bodies. The partial public financing of employment contracts signed between enterprise and scientists and engineers similarly could reinforce this relationship. It is of the utmost importance that the counter incentives to such relationships between business and academia be removed. Foreign direct investment is needed on a much larger scale as a source of new technologies and know-how. It is important that Turkey facilitate the transfer of technology from foreign firms to domestic ones, and in this regard it is important that appropriate technical support be provided to Turkish suppliers of components and materials. Legal assistance also is important, particularly in the areas of technology licensing and acquisition. To take full advantage of FDI, Turkey furthermore should ensure that it is ready to respond quickly to any emerging demand for skilled labor. There is a need to enlarge the innovation policy constituencies in government, the business community, and local communities. Finland provides perhaps the best model for innovation promotion, operating a Science and Technology Policy Council led by the Prime Minister and including the key ministers for education, finance, labor, and industry, as well as representatives of the main business and labor associations. A similar structure in Turkey could play a key role in directing the national innovation system and hence influencing the overall development of the country. An audit, to be conducted under the joint auspices of the business sector and the government, should be made of the areas of greatest importance for entrepreneurship and innovation. This could help to identify improvements needed in areas such as 6

9 procurement, customs regulations, technical norms and regulations, venture funding, the patents regime, and so forth. 1.4 HUMAN RESOURCES FOR THE KNOWLEDGE ECONOMY Turkey has one of the lowest relative levels of employment in the world. Agriculture is still an important sector, employing percent of the work force, but employment in this sector is falling. Manufacturing employment is rising, but it is not keeping pace with the rise in manufacturing value-added. The service sector is absorbing much of the migrant labor from agriculture, but demand from the other major employer of migrant rural labor, construction, seems set to fall away as Turkey s construction boom appears to be nearing its end. This will limit the employment possibilities for the vulnerable group of unskilled adults with only basic education. What is particularly worrisome is the fact that unemployment rates among young people generally are higher among those with higher education levels, indicating that education and training is not attuned to the needs of the economy. This has serious implications for productivity and innovativeness of the economy. It also creates dissatisfaction in an important segment of the population and can reduce the incentive to seek education. Skills and competencies for the knowledge economy are not sufficient to meet current demand, particularly given the rapid pace of technological change. At the secondary school level and especially among graduates of vocational education, who in theory should be fully prepared for entry to the job market there is a high level of unemployment, with significant numbers entering retraining programs immediately following graduation. At the tertiary level there is an imbalance between degree programs and short-cycle technical programs. The level of technical expertise is relatively high, especially in science and engineering, but the technical training does not meet industry needs. There is little non-formal training conducted by private enterprises due to the absence of incentives and occupational standards. If Turkey is to compete in the knowledge economy it must continually upgrade the skills of its work force. Financial and other incentives should be considered to encourage individuals and enterprises to invest in training. These could include tax incentives for individuals and enterprises, targeted incentives to stimulate the development of public and private educational service providers, and special initiatives to promote training by SMEs in both the formal and non-formal sectors. Turkey urgently needs to address several issues, all of which have direct relevance in ensuring that learning systems provide the skills needed for the knowledge economy. It faces three immediate needs: (a) to pass legislation and complete the implementation of a comprehensive system for defining occupational standards and assessments; (b) to complete the planned reforms of secondary education, and in 7

10 particular to refine secondary vocational education, broadening general education programs and moving the more specialized programs to tertiary institutions; and (c) to increase its participation in international assessments, so that it might benchmark its human development capabilities against those of other countries. Priority should be given to reform of the governance of tertiary education, including universities and Higher Vocational Schools (MYOs), with the objective of increasing the linkages between tertiary education and business. Membership of governing boards should be opened to the business community, the methods by which chief officers are selected must be changed, and program-specific advisory boards must be set in place. The government also should examine the options and incentives for increasing participation in secondary education, tertiary education, and adult continuing education, as enrollment is low by international standards. The role of public and private financing should be examined, with a view to identifying how enrollment and access can be improved while maintaining equity and affordability for the poor. There also are particular needs to create incentives to stimulate skill development by SMEs, to improve their productivity and support the knowledge economy, and to stimulate the supply by private and public service providers of high-priority training services. The lack of national and international standards of training are constraining mobility between different levels of the formal education sector, between the formal and nonformal education and training sector, and with institutions outside Turkey. These issues must be resolved if Turkey is to meet the requirements of the EU Barcelona Agreement. The institution of national occupational standards would help address this problem, as would the replacement of university entrance exams by a national secondary school leaving exam. Distance learning programs also should be expanded, and tertiary education quality assurance systems need to be refined in keeping with international norms 1.5 INFORMATION AND COMMUNICATION TECHNOLOGIES FOR THE KNOWLEDGE ECONOMY The ICT sector is strong in some areas but notably weak in others. In general, weaknesses in the ICT environment are the result mostly of regulatory restrictions that limit supply and raise costs. The usage, diffusion, and production of ICT products in Turkey as a result fall short of their potential. In terms of readiness for the e-economy, Turkey is ranked 50 of 82 countries by the World Economic Forum. The full and effective implementation of the e-europe+ program of which Turkey is a member, will advance ICT and enhance the global competitiveness of the sector. Tight interagency coordination of this effort, linked to a comprehensive knowledge economy agenda, is essential. 8

11 Foreign direct investment in ICT is of critical importance. Reducing some of the FDI barriers (such as screening and notification procedures, and management and operational restrictions, including restrictions on the employment of foreign nationals) would enable the creation of a more open environment for both FDI and domestic investment, however. If the ICT sector is to deliver to its maximum potential, new entrants should be given the freedom to provide a full range of services and infrastructure. The cost of access to the Internet in Turkey is among the lowest in the OECD, but while there are a large number of licensed ISPs low Internet charges do not translate into high Internet usage. There are several contributing factors to this paradox of low cost but low penetration, including the lack of investment in infrastructure in general and the Internet in particular; insufficient competition in the provision of electronic communications networks and ICT products and services; insufficient use by the government of e-services; the low quality of local content; and poor computer literacy. To enhance e-commerce and improve the competitiveness of the economy, Turkey must increase Internet penetration among the low-income and regional groups where usage is particularly low. Turkey has significant ICT production capability, but the worsening global telecommunications climate may threaten this source of exports. The traditional arrangements of the ICT sector are unlikely to prosper in an open, competitive telecommunications market, as is required by the terms of EU membership. The government must reexamine the structure of the ICT production sector as it presses toward a knowledge economy. The government could stimulate domestic demand for ICT products and services by lifting its restrictions on ICT business, trade, investment, and consumption. Within the context of Turkey s international commitments it should be possible, at least in part, to satisfy domestic demand from domestic supply. In particular, the upgrade of ICT in the educational system could be a significant source of demand. With the forthcoming liberalization of the market and EU accession Turkey is facing an urgent need to adopt a new, EU-compliant electronic communications regulatory package. New legislation should be enacted as soon as possible to provide the maximum possible impact to the economy of the cost drivers and other benefits of ICT. 1.6 BUSINESS ENVIRONMENT AND THE KNOWLEDGE ECONOMY For its knowledge economy to thrive, a country must have a business-friendly environment that is, a proper mix of regulations, implementation practices, incentives, and institutions. A higher level of risk of investment in new products, new markets, and new technologies must be mitigated by more stable and predictable parameters of business making. 9

12 Turkey, in contrast to the transition economies (including China), has had a functioning market economy for decades. Many market regulations and institutions have developed and matured over time, and the country has basic administrative capacity to deal with emerging regulatory issues. Deficiencies of the business environment are generated at the deeper level of volatile macroeconomic performance, inefficient governance, and an insufficient emphasis on participatory policymaking. Macroeconomic volatility has negatively influenced the development of innovative industries by suppressing private and public demand for knowledge-intensive products, crowding out investments in the innovative sectors by directing financing to the public sector, and by failing to put in place the stable parameters necessary for long-term business planning. Public sector management in Turkey is less efficient in comparison to the OECD average and to many emerging market economies. The distinctions between administration, budgetary entities, and state-owned enterprises (SOEs) are blurred. Employees in SOEs enjoy the status of public servants, with all related protections and rigidities. This has given rise to a culture in which the risk-averse public employee is seen as preferred to the risk-taking private entrepreneur a perception that is particularly harmful for the young generation of professionals, who after receiving a first-rate education at a Turkish university are neither willing nor able to risk undertaking their own business venture. The knowledge economy requires the engagement of civil society in the design and implementation of economic policies and regulations, both on the central and local levels. The knowledge economy, epitomized by Internet, simply will not develop without broad public participation, channeled through a functionally organized system that both produces and shares knowledge. The Turkish business community has developed a number of strong associations that have been advocating the interests of their members to the government on a wide range of issues, such as the customs union with the EU. However, the picture is somewhat blurred by the unfinished evolution of the state-sponsored associations of business, academia, and R&D institutions into organizations that truly represent their members and that are capable of being full partners in policymaking. A good start with involving NGOs into design of the e- Transformation Turkey Project should be continued and further strengthened at the level of specific implementation initiatives. The system of inflationary economy that has persisted in Turkey for decades has deteriorated, however, and there is promise of a new paradigm that is more in tune with the challenges of the global economy. A reformed system of institutions and incentives - much more open to competition and innovation - should produce an even playing field and permit less state interference. Many Turkish businesses have proven their ability to compete internationally and now see the old paradigm as a liability. 10

13 1.7 IMPLEMENTING THE KNOWLEDGE ECONOMY AGENDA Activities designed to support the development of the knowledge-based economy should be coordinated and supported under a long-term, comprehensive agenda. This Knowledge Economy Agenda (the Agenda) should have at its core the e- Transformation Program that is being prepared by the government, but it should also embrace the activities of private and private public stakeholders outside the Program. The primary objective of the Agenda is to identify and prioritize those activities that have the greatest impact on development of the knowledge economy, taking into account the institutional feasibility of those activities given the resources available. The agenda should contribute to the improvement of the competitiveness of the Turkish economy and enterprises by (a) connecting enterprises with sources of knowledge within Turkey and abroad (that is, creating innovation networks); (b) enhancing human capital to meet the requirements of the knowledge economy; (c) providing infrastructure for an information society; and (d) strengthening the regulatory and economic environment to enable knowledge-based initiatives to develop. The Agenda must support Turkey s bid for membership of the European Union and participation in the Lisbon Strategy, the European Research Area, the e-europe 2005 Action Plan, the Barcelona Agreement on educational standards, and other major European initiatives. More broadly, it should increase Turkey s ability to cope with competitive pressure and with the market forces existing within the European Union, as defined by the Copenhagen criteria. The Agenda should support the scaling-up of all activities that have been successful in promoting innovation. This will require a review of the practices of the institutions pursuing these activities to ensure the relevance and efficiency of their programs. The scaling-up of the activities of the Technology Development Foundation (TTGV), for example, could entail a decentralized expansion of its technology development financing program, venture capital funds, technology support services, start-up capital funds, and innovation centers. This could be achieved by way of franchising experience of TTGV and other successful organizations to decentralized networks of private and public private providers. The Agenda also should support the diffusion of the best experience of university industry research centers in responding to specific business needs, following the approach, for example, of those centers currently operating in support of the ceramics, textiles, and other sectors. These new centers could follow the existing model, with partial subsidy from TUBITAK, and could be established on the premises of universities that have strong competences in related fields. Biotechnology-related industries such as health and agriculture, and ICT industries in particular could benefit from the development of such research structures. 11

14 Market-based mechanisms should be used to stimulate demand for and the supply of knowledge economy skills, but these should be supported by public private initiatives wherever necessary and wherever positive international experience exists. On the demand side this would entail creating incentives for citizens, especially young people who are already working in SMEs or are unemployed, to learn knowledge economy skills and to apply these skills in the job market or by starting up their own enterprises. On the supply side, incentives should be created to encourage suppliers (especially private sector suppliers, but also public sector training service providers such as universities, post-secondary technician training colleges, and NGOs) to develop flexible, modular, competency-based training content. A skills development grant program, financing tuition fees and perhaps stipends, could be introduced to assist citizens through the necessary skills training courses. The development of the information society is constrained by the limited access of citizens and enterprises to information infrastructure and to ICT products and services. To help resolve this problem a Universal Access Fund (UAF) could be used in accordance with the electronic communications regulatory package of the EU, the draft law on electronic communications currently under consultation in Turkey, and the objectives of the e-europe 2005 Action Plan. Allocated on a competitive tender basis, this fund could be used to encourage private investment in the provision of ICT access in targeted regions or locations. It is essential that the different institutions and partners that have a vested interest in the knowledge economy work together to implement the activities of the Agenda. The experience of other countries indicates that high-level government officials must be involved, as well as all key interest groups the business community, research and education community, trade unions, and others. The Agenda is also likely to have a regional dimension, requiring therefore the involvement of regional and local authorities, institutions and enterprises, and NGOs in the design, preparation, and implementation of activities in the communities. 12

15 2 KNOWLEDGE AS A PRODUCTION FACTOR Products of the knowledge economy include computer software, media and entertainment content, new pharmaceuticals, and online commerce and banking services. Their common connection is that their production requires a relatively high intellectual input (knowledge) and depends less on the traditional production factors of labor and land. There is also an increasing knowledge content in the production, marketing, and consumption of traditional products such as food or textiles, however. Countries such as the United States, Finland, and Ireland are widely recognized as having successfully transformed to a knowledge economy, dramatically increasing their productivity and global competitiveness, creating new jobs, and, over the longer term, enhancing the well-being of their citizens. This first rank of countries is followed by a second tier of countries, including Turkey, that are competing to evolve their own knowledge economy. Turkey in particular is at a similar stage of development to the EU accession countries, and furthermore is focused broadly on the same markets and products. The difference between traditional production factors and knowledge as a production factor is that the latter is a systemic factor, a result of interlinked socioeconomic developments. These elements, which comprise the four pillars of a knowledge economy, are as follows: the innovation policies, institutions, and incentives necessary for the development and commercialization of domestic and foreign innovations that is, for the creation of a national innovation system; human resource development specifically, the development of a national education system generating a pool of knowledge specialists and a technologyliterate work force; information and communication technologies (ICT); and a business environment conducive to the development of a knowledge economy. The main difference between a knowledge-based economy and a traditional economy is in the way in which knowledge is generated and introduced into the production process. In traditional economies the knowledge component (innovation) typically takes the form of ad hoc, exogenous ideas (such as the inventions of Thomas Edison, for example); in a knowledge economy the knowledge is created and used as an integral part of the process of designing and implementing new business activities and products. This systemic use of knowledge as a production factor gives rise to products the value of which is less and less embedded in their physical components, and more and more in the knowledge component. 13

16 There is a close relationship (but not necessarily an identity) between successful individual knowledge-intensive enterprises and a knowledge economy. It would not be possible to have a knowledge economy without a critical mass of knowledge-intensive enterprises, but at the same time an economy that has knowledge-intensive enterprises but which lacks an adequate business environment, an educated population, a national innovation system, and modern ICT infrastructure would be exposed to the risk of losing its leading position to competitors. In the knowledge economy individual enterprises are exposed to even harsher competition than that which they face in a traditional economy. Knowledge-intensive enterprises enjoy a temporary monopoly of knowledge and generate relatively higher profits, but this knowledge monopoly usually is short-lived and difficult to sustain because the knowledge component typically can be replicated without the need for extensive and costly research and development (R&D). Intellectual property rights are not always adequately protected; they furthermore are by nature controversial and typically are short-lived. 1 A knowledge economy not only has to continuously improve its products but also must continuously diversify. Finland, for example, is under great pressure to diversify from its excessive reliance on Nokia. This study is organized as follows. Section 3 looks at the lessons learned from the leaders in the knowledge economy, and assesses Turkey s potential competitors. Section 4 examines the conditions, policies, and institutions that make possible the innovation process (that is, the process from idea to commercialization). Sections 5 and 6 assess the environment in Turkey and the policies that are in place to support improvement in two key areas: human development and ICT. Section 7 assesses Turkey s business environment and identifies areas in need of reform if the knowledge economy is to thrive. Finally, Section 8 presents suggestions for the next steps that the country should take to meet its knowledge economy agenda. Annex 1 summarizes these policy recommendations and Annex 2 presents comparative statistical data. 1 The recent political debate around generic HIV/AIDS drugs, and the follow-up compromise between the governments and pharmaceutical companies holding patents for these drugs, provide perhaps the best example of the limited nature of intellectual property rights. 14

17 3 GLOBAL LEADERS AND COMPETITORS: LESSONS FOR TURKEY 3.1 KEY SUCCESS FACTORS IN THE KNOWLEDGE ECONOMY There are clear leaders in the race to a knowledge economy (KE), but no single model has yet emerged to guide transformation in other countries. Different countries have responded to the challenge of transformation in different ways, as informed by their history and culture; their national priorities; their economic status, size, geography, and population; and, last but not least, by the opportunity of the moment. Twenty years ago the United States, Finland, and Ireland were among the least likely candidates to lead transformation to the knowledge economy. In the 1970s and 1980s the United States was losing its competitive and innovative edge to Japan, in the eyes of many analysts as a structural consequence of inefficient corporate governance, declining research capacity, and an outdated model that depended on individual entrepreneurship as a driving force rather than the corporate engine. In the early 1990s Finland, which had enjoyed a privileged position serving the vast markets of the Soviet Union, entered deep recession when those markets were opened to global competition. Ireland traditionally served primarily as a source of relatively inexpensive labor for the United Kingdom. Paradoxically, while the United States, Finland, and Ireland have pioneered the development of the knowledge economy Japan, Russia, and the United Kingdom have been less successful with their own KE agenda. Even a casual comparison of these three top performers shows that they have followed very different models of socioeconomic development. There nonetheless emerge from study of these three cases several policy challenges that are common for any country seeking successful transition to a knowledge economy. These common requirements include primarily: An ability to convert the social and political pressures of the Schumpeterian destruction of old industries, work places, institutions, and shifting demand into opportunities for new economic activity. Recognition of the critical importance of education in preparating society for the challenges posed by the knowledge economy, and as the source of innovations. High-level support for a long-term policy agenda supporting innovations. Specifically, the economic environment should be characterized by low costs of business entry and exit, favorable taxation, active promotion of foreign direct investment (FDI) and of the protection of intellectual and other property rights, and low trade barriers. 15

18 Provision of support to private initiatives and to public participation in the modernization of information and communications technology (ICT) infrastructure. Government use of ICT and public funding of research and development (R&D). Support for a culture of innovation. This culture should be characterized, at least in part, by social acceptance of high rewards for innovators and entrepreneurial risktakers and by the existence of demand for new products and services. There are no obvious common characteristics and patterns among countries, including Turkey, that are aspiring to become knowledge economies. Comparison of Turkey with Poland, Mexico, and the Republic of Korea underlines this point. 2 Progress toward a knowledge economy can be modeled at a basic level in terms of the relationship between an outcome (high-technology exports as a proxy of knowledgeintensive, globally competitive production) and regulations and inputs that are conducive to development of a knowledge economy (see Table 1). In this context Korea represents the most consistent model of the relations between outcomes and inputs and regulations (with the exception of FDI). 3 Poland, despite high FDI and despite possessing a high percentage of professional workers, scores poorly for outcomes. Mexico, which has a relatively high level of outcomes, scores poorly in terms of R&D expenditure and flexibility of regulations. Table 1. KE progress in Turkey, Poland, Mexico, and the Republic of Korea Turkey Poland Mexico Korea Outcomes High-technology exports (percentage of manufactured exports, 1999) Inputs Professional/technical workers (percentage of the labor force, 2000) FDI (percentage of GDP, ) Total expenditure for R&D (percentage of GNI, ) Internet hosts per 10,000 people (2000) Regulations World ranking of business competitiveness (2003) Source: Various; see Annex 2. These observations suggest that knowledge cannot be introduced as a production factor in the manner of a classical production function, whereby increased input of 2 3 Finding proper comparators is more an art than a science. For general benchmarking, population and the level of economic development are perhaps the most important indicators. In this context, Poland, the Republic of Korea, and Mexico may be the most suitable comparators for Turkey (see Annex II). Specific institutional solutions (best practices) have to be decided on a case-by-case basis. For more information on Korea s effort advance its knowledge economy agenda, see Korea and the Knowledge-Based Economy, World Bank Institute, OECD,

19 capital and labor is expected to result in increased output. The successful introduction of knowledge to an economy is foremost a social process, articulated and implemented as an interplay between the government, business, academia, nongovernmental organizations (NGOs), and society at large. Transformation to a knowledge economy is driven by multiple and diverse forces of change, manifest in the demand for and the supply of knowledge. This demand for and supply of knowledge may be generated by consumers (households), other businesses, government, civil society, or foreigners (through foreign trade and FDI). The way in which these different sources make up the overall demand and supply varies between countries and over time. A knowledge economy will not be sustainable if introduced from the top alone, by government fiat, nor can it be generated solely by private interest, without the participation of the state as a regulator and consumer of innovative products. A proper mix of private and public supply of and demand for knowledge is key to the success of the transformation. The experience of the leading countries shows that to build a successful knowledge economy the national innovation system, human development, and ICT and business environment must develop in parallel and interact efficiently. The challenge for government is to identify the interrelations and synergies between these areas, rather than to merely operate separate sectoral policies. Transformation to a knowledge economy is a continuous process requiring a strategic view, adjusted over time to respond to changes in the driving forces, to challenges that emerge from competitors, and to opportunities represented by new technologies. In this process it is important to keep in mind the following questions: What are the forces of change impacting the knowledge economy in terms of its economic and institutional framework, human resources development, the information society, and the national innovation system? What are driving forces in the demand for and supply of a knowledge economy? How do particular events enhance the knowledge economy by: closing digital gaps (in terms, for example, of hardware, software, ICT infrastructure, or computer literacy), closing regional gaps, closing social gaps (for example, by alleviating poverty or enhancing gender equality), and strengthening an open (civil) society (specifically, what mechanisms and institutions)? In its 2000 Lisbon Strategy, the European Council set out a 10-year plan to make the EU by 2010 the world s most dynamic and competitive knowledge economy. The strategy advises EU member states, among other recommendations, to increase their 17

20 R&D expenditures to as much as 3 percent of gross domestic product (GDP). In light of the previous discussion, this target should be treated as an ex post monitoring tool rather than as an ex ante formula for success. Attainment of the Lisbon goals will not be achieved simply through the administrative allocation of resources to R&D; for while at one level R&D may be considered a driving force for growth, it is at the same time a consequence of deep economic and social changes KEY CHALLENGES FOR TURKEY Preliminary assessment of Turkish readiness for the knowledge economy, as encapsulated in Table 1, shows that much work remains to be done. The country has in some important areas in fact furthermore regressed: The standardized diamond of Turkish readiness to succeed in a knowledge economy has shrunk in the last few years in two important dimensions (see Figure 1). 5 First, Turkey has in terms of economic incentives suffered large losses relative to its competitors. Second, its preparedness in terms of providing the education required for it to be able to respond to the needs and challenges of the knowledge economy also has declined. This is particularly worrisome because the baseline is at a relatively low level. The country s agenda for reform in education clearly is inadequate. Econ. Incentive Regime 10 5 Information Infrastructure 0 Innovation Education most recent Public R&D expenditure is 79 percent of the EU average; however, business-financed R&D is only 21 percent of the EU average (see Annex II). In the WBI methodology the highest level (10) is a level of selected indicators in a given year in the most advanced country. The smaller the diamond for a given country (Turkey), the poorer are its abilities to successfully compete in the knowledge economy (for detailed indicators see Annex II). 18

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CHAPTER 11 CONCLUSIONS AND IMPLICATIONS 1. Jobs, an urgent challenge The world is facing an enormous jobs challenge, a challenge that is twofold. First, 600 million jobs must be created by 2020. Second,